Dividends: Start Screaming

By

Jason Zweig

Updated Oct. 12, 2012 6:29 p.m. ET

Enough about the "fiscal cliff." What about the dividend cliff?

At one second after midnight on Jan. 1, 2013, the maximum tax rate on dividends is likely to go from 15% to either 18.8% or 43.4%. The best-case scenario: Congress retains the top dividend-income tax rate of 15%, and the only increase is the scheduled 3.8% surtax on investment income for high earners. The worst case: Congress decides dividends are to be taxed at ordinary-income rates, and the highest rate jumps to 39.6%, plus the same 3.8% surtax.

ENLARGE

Analysts say many companies are waiting to see what Congress does before they finalize their payment plans. There are no significant tax or financial consequences for companies that speed up a dividend.
Christophe Vorlet

In just the first two weeks of January 2012, U.S. public companies paid $16.1 billion in dividends, according to Robert Gordon, a tax expert at Twenty-First Securities in New York. If they pay at approximately that rate again, shifting those distributions a few days earlier so they fall before the end of this year would make a significant difference to investors' after-tax wealth.

Wal-Mart Stores, for instance, already has declared that it will pay its next dividend on Jan. 3, 2013. Its dividend last year amounted to $1.25 billion. Based on publicly available information, Wal-Mart's upcoming January dividend will total approximately $1.34 billion. By moving the payment of the dividend up a mere three days—from next Jan. 3 to this Dec. 31—Wal-Mart could reduce its investors' tax bills by a total of $35 million at the low end and $263 million at the high end, estimates Mr. Gordon.

It doesn't sound as if Wal-Mart will move its payment date. "Our dividend record and payable dates have been set," says Randy Hargrove, a spokesman for Wal-Mart.

Analysts say many companies are waiting to see what Congress does before they finalize their payment plans. There are no significant tax or financial consequences for companies that speed up a dividend, analysts say.

There is some precedent for doing shareholders a favor by paying out income before it becomes taxable at a higher rate. Two years ago, when Congress also looked likely to jack up taxes on dividends, roughly two dozen companies, including Sara Lee, accelerated their January 2011 payouts into December 2010.

That time, the dividend-tax rate stayed put after a congressional reprieve. This time, a rise to at least 18.8% from 15% is all but inevitable; the odds of a tripling to 43.4% are uncertain.

"I am advising all my wealthy clients [who own private corporations] to pay their dividends this year" before rates rise, says Robert Spielman, a tax accountant at Marcum LLP in Melville, N.Y. "So why shouldn't public companies who care about their shareholders' well-being do the same thing?"

Daniel Peris, co-manager of the Federated Strategic Value Dividend mutual fund, is concerned that higher tax rates might provide some companies with an excuse to avoid raising dividends. "It's yet another pretext not to send out a check to company owners," he says.

That excuse isn't justified by history, of course. For much of the past century, wealthier investors paid taxes on dividends at far higher rates than today's—and companies still managed to pay out much more of their net income to shareholders than they do now. C.J. MacDonald, a portfolio manager at Westwood Holdings, an investment firm in Dallas, points out that companies paid out roughly 60% of their earnings as dividends in 1960—even though the tax rate on dividends topped out then at a confiscatory 91%.

Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, estimates that the lower tax rates on dividends that have prevailed since 2003 have put an extra $358 billion into individual investors' pockets.

Even if tax rates do triple, investors still would be better off with bigger payouts. History also shows that high-dividend-paying companies outperform dividend misers.

More than seven decades ago, in his classic book "Security Analysis," the great investor Benjamin Graham made a call so radical that it still sounds shocking today. Complaining of the "despotic powers" wielded over dividend policy by corporate executives and directors, Graham argued that companies should no longer be allowed to direct surplus cash away from paying dividends—even for reinvesting in the business—without first obtaining formal "consideration and appraisal" from their investors, most likely through a vote at the annual meeting.

Capitalist to his core, Graham was dead serious with this Bolshevik-sounding suggestion. He wanted shareholders—who, after all, own the company—to force management to provide at least a general justification for using cash for any purpose other than paying a dividend.

With the percentage of profits paid out as dividends today near all-time lows, at 34%, Graham's drastic proposal is just what we need to cattle-prod companies out of being such skinflints.

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